As we approach the end of 2018, equity markets are having a difficult time, particularly in the US markets where volatility has evidently increased. In fact, at the time of writing, the S&P500 Index is experiencing its worst December return since 1931, falling over 7% month-to-date. The chances of a “Santa Claus Rally” flying in to gift a positive return by the end of the year seems remote. So, what is going on, and is this a time for panic?
We believe that not much has changed. The US economy is still providing strong data points. Economic growth is good, and the employment market is strong. Wage growth is increasing, and inflation numbers are also picking up, but not to levels that would give the US Federal Reserve cause for concern. In fact, the recent fall in the oil price should help dampen inflationary expectations as US drivers start to notice a reduction in cost at the petrol pumps. The market expects the US Federal Reserve to continue to slowly increase interest rates, as it did on the 19th December, although expectations for further increases in 2019 have started to wane.
Herein lies the problem. Slowly rising interest rates in the US have the effect of tightening financial conditions. This is at a time of increasing overall US debt levels following an era of low rates and the impact of the tax legislation of last year. The benefits of those tax cuts for companies have already been priced in, leaving the US with the bill, i.e. increased debt with higher interest, to pay. However, 2019 forecasts are for slower, not stalling, economic growth. Equity markets may react should those expectations change.
In addition, there is so much going on in the rest of the world. The US-China trade tariffs could have a lasting impact on global trade. The EU is beset by political concerns, such as the French protests, tensions between Italy and the EU over their budget, and German politics post-Angela Merkel. This is at a time when both EU and Chinese economic growth is slowing, and as the ECB has started to reduce its Quantitative Easing purchases. The Brexit saga continues to roll on, without any real clarity on what is going to happen between now and 29th March.
Of course, none of this is new. The market has been evaluating the impact of all these issues for some months. Throughout the year, the US equity market has outperformed other developed markets by some margin, and the recent performance has allowed this divergence to narrow somewhat. December is usually a month with lower liquidity which may increase volatility and accentuate market moves. There are increasing risks affecting the equity markets, as outlined above, and one should remain vigilant over how these risks may impact returns.
The recent correction has taken a lot of the froth out of the equity valuations, and there are still inherent risks. However, we do not believe that this is a time to panic. This is a time for vigilance and a disciplined approach. Portfolio diversification is paramount to alleviate unexpected risks and we continue to monitor and evaluate market conditions. No doubt 2019 will bring its own opportunities.
May we wish you a very Happy Christmas and a peaceful and prosperous New Year.
We believe that not much has changed. The US economy is still providing strong data points. Economic growth is good, and the employment market is strong. Wage growth is increasing, and inflation numbers are also picking up, but not to levels that would give the US Federal Reserve cause for concern. In fact, the recent fall in the oil price should help dampen inflationary expectations as US drivers start to notice a reduction in cost at the petrol pumps. The market expects the US Federal Reserve to continue to slowly increase interest rates, as it did on the 19th December, although expectations for further increases in 2019 have started to wane.
Herein lies the problem. Slowly rising interest rates in the US have the effect of tightening financial conditions. This is at a time of increasing overall US debt levels following an era of low rates and the impact of the tax legislation of last year. The benefits of those tax cuts for companies have already been priced in, leaving the US with the bill, i.e. increased debt with higher interest, to pay. However, 2019 forecasts are for slower, not stalling, economic growth. Equity markets may react should those expectations change.
In addition, there is so much going on in the rest of the world. The US-China trade tariffs could have a lasting impact on global trade. The EU is beset by political concerns, such as the French protests, tensions between Italy and the EU over their budget, and German politics post-Angela Merkel. This is at a time when both EU and Chinese economic growth is slowing, and as the ECB has started to reduce its Quantitative Easing purchases. The Brexit saga continues to roll on, without any real clarity on what is going to happen between now and 29th March.
Of course, none of this is new. The market has been evaluating the impact of all these issues for some months. Throughout the year, the US equity market has outperformed other developed markets by some margin, and the recent performance has allowed this divergence to narrow somewhat. December is usually a month with lower liquidity which may increase volatility and accentuate market moves. There are increasing risks affecting the equity markets, as outlined above, and one should remain vigilant over how these risks may impact returns.
The recent correction has taken a lot of the froth out of the equity valuations, and there are still inherent risks. However, we do not believe that this is a time to panic. This is a time for vigilance and a disciplined approach. Portfolio diversification is paramount to alleviate unexpected risks and we continue to monitor and evaluate market conditions. No doubt 2019 will bring its own opportunities.
May we wish you a very Happy Christmas and a peaceful and prosperous New Year.
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